Inspiration from physics for thinking about economics, finance and social systems

Wednesday, December 11, 2013

Secular stagnation.... just a poor excuse?

Larry Summers recently made some waves with his proposal that maybe we're in a new era of "secular stagnation," in which low growth is the norm, and much of it comes through temporary and artificial bubbles. Paul Krugman backed the idea here. At face value, it all seems somewhat plausible, but also sounds a lot like a "just so" story to cover up and explain why economic policy and low interest rates haven't been enough to encourage new growth, yet also haven't caused inflation. It also fits together quite well with the usual stories told about the failure of ordinary policy at the zero lower bound, which turns ordinary economics on its head.

Now, I don't want to say that story is completely wrong, but remember that it comes out of quite standard macro analyses based on representative agent models with individuals and firms optimizing over time, and where -- perhaps most importantly -- things like debt overhang do not enter in any way into explaining how people are behaving (and why they may be hugely risk averse). That should be enough to raise some major questions about the plausibility of the story, especially in the aftermath of the biggest financial crisis in a century. For a lot more on such doubts, see the illuminating recent paper Stable Growth in an Era of Crises by Joseph Stiglitz.

But also see this convincing counterargument by some analysts at Independent Strategy, as discussed in the Financial Times. From Izabella Kaminska's discussion:

From the note, their main points are:

• There is no shortage of high return investment projects
in the world. And the dearth of global corporate investment, which
drove the great recession, means that productive potential is shrinking
despite corporate profitability, leverage and cash balances being sound.

• The three ingredients for growth are a) a stable macro environment;
b) a sound banking system; c) economic reforms that encourage
entrepreneurship. What is missing right now is private sector confidence
in the ability of governments and central bankers to provide all three.

• Credit bubbles can boost growth only temporarily and incur heavy
costs in terms of subsequent deleveraging and misallocation of
resources.

And expanding a bit further, they add:

Secular stagnation is a myopic and short-term view for
two reasons. First, it is based on the experience of the Anglo-Saxon
economies and parts of Europe currently as well as Japan since the
bursting of the bubble at the start of the 1990s. Krugman muses that
interest rates should be set at the growth rate of populations, because
they would then be equal to a society’s potential capital productivity
(and the long-term return on it). But the change in population growth is
less relevant than the rise in productivity of an expanding workforce.

Take Germany: its population is ageing and its net population growth
is slowing to a trickle (although that may be improved by increased net
immigration from southern and eastern Europe). But Germany’s
productivity level and growth is high (as is total factor productivity,
expressing the gains from technology). Italy has a similar stagnation in
its working population, but its real GDP growth has disappeared because
of the fall in total factor productivity — Figure 1.

Actually, this push back isn't really surprising. It's what you get if you take the longer historical view, rather than trying to make excuses for why economic theory still can't make sense of things (the theory is poor, that's why!). As a couple of economists from Goldman Sachs noted just after Summers' speech:

"Our view of the recent weakness is more cyclical than secular... The slow rate of recovery in recent years is roughly in line
with the performance of other economies following major financial
crises, as shown by Reinhart and Rogoff, and the reasons for the weakness in aggregate demand over the last few years have now begun to diminish."

This refers to the great book by Reinhart and Rogoff, by the way, not their other discredited paper.

2 comments:

"Take Germany: its population is ageing and its net population growth is slowing to a trickle (although that may be improved by increased net immigration from southern and eastern Europe). But Germany’s productivity level and growth is high "

Where would Germany be without the euro acting as a wealth transfer mechanism from the south to the north? Germany is a bubble itself.

Let's talk physics and government deficit spending. Liberal economists think that increasing government deficit spending will stimulate the economy to grow to an extent that it will pay for itself in future tax revenue (assuming tax rates are high enough). This in physics is a perpetual motion machine, which don't work because they violate the physical law of the conservation of energy. Same must be true for economics. Actual result is deficit spending and high tax rates produce a low return on investment (negative?) which discourages employment and results in economic stagnation.

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This blogexplores the potential for the transformation of economics and finance through the inspiration of physics and the other natural sciences. If traditional economics has emphasized self-regulation and market equilibrium, the new perspective emphasizes the myriad positive feed backs that often drive markets away from equilibrium and cause tumultuous crashes and other crises. Read more about the idea.

Who am I?

Physicist and science writer. I was formerly an editor with the international science journal Nature and also the magazine New Scientist. I am the author of three earlier books, and have written extensively for publications including Nature, Science, the New York Times, Wired and the Harvard Business Review. I currently write monthly columns for Nature Physics and for Bloomberg Views.